When we first came up with the idea of an ‘interim periodic review’ or IPR, we hoped it might generate a little interest. Well it did, in spades! We’ve now conducted a number of IPRs for clients in the UK, continental Europe and in Asia, and we have more to do in the Caribbean in the first quarter of 2016 (tough work but someone has to do it!).

As a quick refresher, an IPR is designed for responsible officers (ROs) in firms subject to FATCA. FATCA rules mean that ROs must make certifications of adequate controls to the IRS every three years off the back of formally conducted “Periodic Reviews” which are mandated in Revenue Procedure 2014-39. Now, if you’re in an IGA market, that requirement is much diluted to be replaced by domestic law in which the compliance load is reduced. That said, everyone, and I mean everyone I’ve spoken to has two comments to make – (i) I don’t want to wait three years before I find out in a Periodic Review that I’ve been getting it wrong all along, and (ii) even if I don’t have to meet the stringent requirements of a full blown FATCA Periodic Review, I’d rather know that I meet the higher standard than aim for the lower standard. Hence the IPR is becoming very popular with ROs as an interim, independent health check to make sure that what they think they are doing is actually giving them the benefit they expect.

So, what have we found in these interim periodic reviews? First, I need to caveat my comments by pointing out that we are not targeting the big banks. They already have massive teams of people crawling all over their compliance and operational functions and are more adequately handled by the usual big accounting firms. No, we’re targeting the smaller, second tier firms and, to quote one such, they often take a ‘risk-based approach to compliance’. In other words, there are some things they believe they can either ignore or do a minimal effort on given that they have limited resource. Trust me, there are lots of firms like these.

Our main findings across all the IPRs we have conducted so far is that most small to medium sized firms would fail a Periodic Review if they had to undergo one now. This might be somewhat surprising since we are only a few short months into the compliance requirement and you’d expect firms to have taken a good look and done something at the outset.

They have taken a look, but our second main finding is that there is a substantial lack of understanding in these firms and a high degree of assumption that they can engage very minimal effort and still be compliant. Some in fact assume that the mere acquisition of a GIIN is what makes them compliant! There is also a worrying level of disconnect between these second tier firms and their upstream counter parties – often qualified intermediaries or US Withholding Agents. When we question the operational structures in place, thirdly, we find almost no assistance or explanations being given by USWAs and QIs to their customers, the reason most often cited being risk aversion or a belief that providing information to their customers constitutes tax advice. Where such direction is being given, there is often no differentiation from above about what is a regulatory requirement and what is actually just a commercial policy decision. Everything is being wrapped up in ‘this is the regulation’.

When we conduct an IPR, we are typically using the terms of Revenue Procedure 2014-39 as our base, whether or not our client is subject to these terms – because this is the higher standard. This Rev. Proc. has a couple of very important changes to its predecessor in IRC Chapter 3, most notably that the firm must have adequate resources and adequate training in place as well as adequate documentation of its policies and procedures for compliance. Our fourth main finding is that most firms we’ve tested do not have adequate resources and have, at best, only minimal training in place and that only on an ad hoc basis.

Once we’ve assessed resources, usually by interview with key staff, we drop down into a more granular analysis. Are there written policies and procedures? Do these actually work to produce a compliant organisation? Our fifth finding is that less than 50% of firms create separate and discrete FATCA compliance manuals. The rest embed FATCA within existing KYC and AML policies and procedures. Either is, of course, acceptable although the latter requires more effort. What’s more concerning is the degree to which these policies and procedures actually work.

The foundation of FATCA is due diligence. If you get this right, most of the rest of compliance should follow much more easily. Most firms have updated their on-boarding procedures and documentation to establish FATCA status and many have adopted the US W-8 forms as the basis of their operation, since these absolve the firm of liability. However, our sixth finding is that almost none of the firms analysed have adequate validation procedures for forms W-8 or for proper validation of Chapter 4 status. This is worrying because the limitation on liability provided by these forms is contingent on proper validation both on the face and against KYC and AML information. Absent that, there is liability on the financial institution. Our seventh finding is that, in our analyses of both FATCA and Chapter 3 uses of W-8s, we have found an extraordinary 60%+ of W-8s to be unfit for purpose.

We get finally to reporting and, in many cases, firms should have already reported either domestically or direct to the IRS with respect to US account holders, non participating FFIs and in some cases, recalcitrant account holders. Thankfully, our eighth finding is that most firms analysed do have an understanding of their reporting requirements and have either successfully reported or have plans in place. The thing that concerns us is that the systemic weaknesses we’ve found prior to the reporting process leads us to question the value of the data being submitted. The Tax Justice Network assessed tax evasion in 2012 at $280Bn a year. The logic of FATCA is to provide the IRS with an independent source of information so that it can check this data against domestic tax filings to make sure that all global income has been declared by US taxpayers and appropriate tax paid. It looks to us as though the data set being provided, on the one hand, is likely to be larger than that required by some significant margin due to risk aversion within FFIs and, on the other hand will be missing critical identification of evasion due to failures in compliance for the reasons we have outlined above which, based on the current rules, won’t be formally identified for another two years yet.

If the level of compliance based on this rather simple, relatively small and unscientific analysis, is even remotely representative of the larger population of FFIs (170,000+), there would appear to be some startling weaknesses in this regulatory structure through which one could drive the proverbial truck. The IRS, looking at their communications output, seems focused currently on getting the reporting end of the equation to work. It would seem that they might be equally well focused on making sure that the preparatory piece is actually working too and that’s what appears to be most challenging for FFIs. What’s also interesting is that although the IRS now has a very significant regulatory reach beyond its own borders with IRC Chapters 3 and 4, there is currently not one representative from outside the US on their information reporting program advisory council (‘IRPAC’). If there was, perhaps the global community would have a voice that could feed back some of the ‘rest of world’ constructive commentary back into the system.

If you’d like to know more about Interim Periodic Reviews please contact me at [email protected] or follow me on twitter @RossKMcGill.

Image Credit: Sam Valadi